There's no rushing market's return to its previous high

Published: Monday, March 26, 2012 at 1:00 a.m.

Last Modified: Saturday, March 24, 2012 at 2:18 p.m.

The Chinese philosoper Lao-tzu wrote around 550 BC that "A journey of a thousand miles begins with a single step." In other words, to get to the finish line you must begin. The stock market, as measured by the Dow Jones U. S. Total Market Index, began its "journey of a thousand miles" on March 10, 2009, the day after hitting its 12.5-year closing low.

As I write this, it's ahead about 115 percent from that point but still about 7. 3 percent below its record close on October 9, 2007.

Thus, the "journey" is well under way. But when will it be completed? The answer is both psychologically and financially important to investors -- financially, because it will essentially mean that many investors' portfolios will be back to their all-time highs, psychologically because it will mean the market has totally erased that debacle and is prepared for new highs.

Together, these will satisfy many investors' need to "get even." This need seems to be an integral part of human nature. It appears in everything from taking revenge for being wronged to the aforementioned trying to recover from a financial setback.

For those experiencing a significant financial loss, this need to get even can lead to self-defeating behavior. Because they lack the patience to await the inevitable market recovery, they make investments that are riskier than they should, for example investing in the most speculative and volatile stocks. If they are extremely fortunate and these stocks do well for some time, they don't sell because they're afraid that they will miss out on future gains. Then the stocks collapse and they're worse off than when they started.

To succeed in the stock market, investors need patience. The market always rewards patient investors -- but on its schedule, not the investors'.

Expanding on Lao-tzu's philosophy; it's necessary to take the first step but it's also necessary to have the patience to finish the journey.

In terms of the market's current journey, what might that mean?

Back three years ago, when I first wrote on this topic, I said, "While no one knows how long it will actually take the broad market to fully recover, the odds favor at least five years. This means that the market recovery is likely to take longer than many investors expect or hope for."

Let's see what forecasts we can make now, based on how far the market has actually come. As mentioned earlier, the market is still down about 7. 3 percent from its all-time high. This means -- due to the magic of mathematics -- it must go up about 7. 9 percent to get even.

If it were to take two years for this to occur, then the market would need an average compound annual rate of return of only about 3. 9 percent. This is below the historical long-term compound annual market return of almost 10 percent and even below the 6 to 7 percent some propose as the "new normal" for stock market compound average performance over the next decade. If the market were to return the historical rate, investors could be even in under a year.

Based on this information, it would be reasonable to say that the 2009 forecast was in line with reality and that about one year is a reasonable planning basis now, but by no means is it a sure thing.

What actions, if any, should investors take in the meantime?

As mentioned previously, they should think carefully before increasing the risk in their portfolios. The economic and political uncertainty here and abroad could still result in a sharp market drop. The increased risk could result in larger relative losses.

They should definitely continue sound investing strategies, for example, rebalancing their investments between the various broad asset classes -- stocks, bonds and cash; not trading excessively; selecting low-cost investments like "no-load" index funds; selecting investments that they understand; avoiding investments that sound too good to be true.

The market will surpass its previous all-time high; patience will be ultimately and generously rewarded.

Send comments and questions to Robert Stepleman, Business News, Herald-Tribune, 1741 Main St., Sarasota, FL 34236, or rsstepl@tampabay.rr.com

<p>The Chinese philosoper Lao-tzu wrote around 550 BC that "A journey of a thousand miles begins with a single step." In other words, to get to the finish line you must begin. The stock market, as measured by the Dow Jones U. S. Total Market Index, began its "journey of a thousand miles" on March 10, 2009, the day after hitting its 12.5-year closing low.</p><p>As I write this, it's ahead about 115 percent from that point but still about 7. 3 percent below its record close on October 9, 2007.</p><p>Thus, the "journey" is well under way. But when will it be completed? The answer is both psychologically and financially important to investors -- financially, because it will essentially mean that many investors' portfolios will be back to their all-time highs, psychologically because it will mean the market has totally erased that debacle and is prepared for new highs.</p><p>Together, these will satisfy many investors' need to "get even." This need seems to be an integral part of human nature. It appears in everything from taking revenge for being wronged to the aforementioned trying to recover from a financial setback.</p><p>For those experiencing a significant financial loss, this need to get even can lead to self-defeating behavior. Because they lack the patience to await the inevitable market recovery, they make investments that are riskier than they should, for example investing in the most speculative and volatile stocks. If they are extremely fortunate and these stocks do well for some time, they don't sell because they're afraid that they will miss out on future gains. Then the stocks collapse and they're worse off than when they started.</p><p>To succeed in the stock market, investors need patience. The market always rewards patient investors -- but on its schedule, not the investors'.</p><p>Expanding on Lao-tzu's philosophy; it's necessary to take the first step but it's also necessary to have the patience to finish the journey.</p><p>In terms of the market's current journey, what might that mean?</p><p>Back three years ago, when I first wrote on this topic, I said, "While no one knows how long it will actually take the broad market to fully recover, the odds favor at least five years. This means that the market recovery is likely to take longer than many investors expect or hope for."</p><p>Let's see what forecasts we can make now, based on how far the market has actually come. As mentioned earlier, the market is still down about 7. 3 percent from its all-time high. This means -- due to the magic of mathematics -- it must go up about 7. 9 percent to get even.</p><p>If it were to take two years for this to occur, then the market would need an average compound annual rate of return of only about 3. 9 percent. This is below the historical long-term compound annual market return of almost 10 percent and even below the 6 to 7 percent some propose as the "new normal" for stock market compound average performance over the next decade. If the market were to return the historical rate, investors could be even in under a year.</p><p>Based on this information, it would be reasonable to say that the 2009 forecast was in line with reality and that about one year is a reasonable planning basis now, but by no means is it a sure thing.</p><p>What actions, if any, should investors take in the meantime?</p><p>As mentioned previously, they should think carefully before increasing the risk in their portfolios. The economic and political uncertainty here and abroad could still result in a sharp market drop. The increased risk could result in larger relative losses.</p><p>They should definitely continue sound investing strategies, for example, rebalancing their investments between the various broad asset classes -- stocks, bonds and cash; not trading excessively; selecting low-cost investments like "no-load" index funds; selecting investments that they understand; avoiding investments that sound too good to be true.</p><p>The market will surpass its previous all-time high; patience will be ultimately and generously rewarded.</p><p><i>Send comments and questions to Robert Stepleman, Business News, Herald-Tribune, 1741 Main St., Sarasota, FL 34236, or rsstepl@tampabay.rr.com</i></p>